USD/INR: New Record Highs With Weakening Rupee Inevitable

Weekly Chart
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The Channel Top that has been keeping USD/INR bulls at bay has finally been broken. Prices cleared the resistance level and continued strongly, reaching a record high of 62.78 last Friday. With the resistance cleared, USD/INR is effectively in uncharted territory, and the doors are now open for even stronger bullish momentum from here.

Looking at this morning’s price action, bulls managed to ignore the early dip, a last ditch effort by bears to send price back into the rising Channel, showing that current bullish momentum is strong and certainly not a fluke. With that in mind, we can expect further gains in the near term before an inevitable pull back occurs.

Fundamentally, the rupee depreciating initially due to the weakening economy, but was also prompted by foreign funds seeking to escape Indonesia’s shores. The problem is made worse by the fact that inflation in India is extremely high, resulting in no possible quick fix by the RBI, India's central bank. If RBI increases rates to save the rupee, the economy will worsen more quickly, resulting in long-term rupee weakness.

Decreasing key policy rates further may help the economy slightly, but will come at the expense of an even weaker rupee in the short-term, on top of fueling the already high inflation rate which is detrimental to the economy as well. Hence a weaker rupee outcome can be expected if the RBI continues to engage the market using conventional monetary policy methods. However, the RBI does not have the firepower to engage the market using non-conventional methods as India is currently running a record current account deficit. No matter from which angle you look at it, it seems that a weakening rupee is inevitable.

This problem is perhaps exacerbated due to the resurgence in US yields. the 10Y Treasury note is approaching 2 year highs, and presents a much safer investment alternative to holding rupee assets, where interests are high but nonetheless barely able to cover inflation growth. Given that the rupee is depreciating right now, while the USD is strengthening, holding Treasury notes becomes much more attractive, and carry traders that are still holding on to the rupee may be tempted to switch in order to earn a much more stable 2-3% return (potentially more if the Fed does carry out a tapering effort in September). With Fundamentals and Technicals lining up nicely, it is not hard to imagine the rupee heading much higher in the next few months.

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